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May 27 — IRS proposed regulations regarding taxes on gifts from covered expatriates should include a “safe harbor” provision on certain transfers from non-covered expatriates, the American Bar Association Section of Taxation and Section of Real Property, Trust and Estate Law said.
Tax code Section 2801 imposes a tax on covered gifts and bequests received by a U.S. citizen or resident from a covered expatriate, with the tax burden falling on the recipient.
The Internal Revenue Service's proposed regulations (REG-112997-10) list several types of indirect transfers that qualify as “covered” transfers.
Under the rules, an indirect acquisition of property includes property acquired by or on behalf of a U.S. citizen or resident, either from a covered expatriate or from a foreign trust that received a covered gift, through one or more foreign trusts, other entities or a person not subject to the Section 2801 tax, the groups said in a May 26 letter to the IRS. In the definition of an indirect acquisition of property, the regulations also include any property acquired by a U.S. citizen or resident in other transfers not made directly by the covered expatriate.
“The final regulations should be simplified by adding a safe harbor provision that mitigates the broad reach” of the indirect transfer rules, the ABA sections said.
The safe harbor could be modeled on Treasury Regulations Section 1.643(h)-1, which provides that any property transferred to a U.S. income tax resident by another person who received property from a foreign trust will be treated as property transferred directly from the foreign trust to the U.S. resident if the intermediary received the property from the trust in a plan to avoid U.S. tax, the sections said.
The regulations under Section 1.643(h)-1 presume that transfers made by a related intermediary within 24 months of receipt are an attempt to avoid tax. This provision could be modified to apply to indirect Section 2801 transfers as well, the groups said.
The sections commented on the IRS's and Treasury Department's request for answers to the question of how contributions to or distributions from a non-electing foreign trust to a U.S. citizen spouse could qualify for the marital exception under Section 2801.
The proposed regulations provide that covered gifts and bequests don't include property that would qualify for a marital deduction under Sections 2056 and 2523. That exception extends to transfers made in a trust. However, under the regulations, a qualified terminable interest property (QTIP) trust or qualified domestic trust (QDOT) marital deduction will not be allowed unless a valid QTIP or QDOT election is made.
If a covered expatriate doesn't have any U.S. situs property, and therefore doesn't have a gross estate within the meaning of Section 2103, it may not be possible for a valid QTIP or QDOT election to be made, the groups said.
“In such a situation, we recommend that the regulations be modified to (1) permit either the non-electing foreign trust or the U.S. resident spouse to make the relevant election on Form 708 or (2) to explicitly permit the executor of the CE’s estate to file Form 706NA and to make the relevant election for Section 2801 purposes,” the ABA sections said.
The groups also said it would be appropriate for the final regulations to treat distributions from a non-electing foreign trust to a U.S. citizen spouse as an indirect covered gift from the covered expatriate. Those transfers would then qualify for the marital deduction and no tax under Section 2801 would be due.
The ABA sections also responded to IRS and Treasury requests for comments on how to minimize the burden association with a foreign trust electing to be treated as a domestic trust, while at the same time securing the government's interest in collecting tax from the trust.
A foreign trust must elect to be treated as a domestic trust under Section 2801 by filing Form 708. Under the proposed regulations, the electing trust must continue to fill out the form in subsequent years even when no additional covered gifts or bequests are received.
“We recommend that Treasury and the Service consider modifying the annual filing requirement for electing foreign trusts,” the groups said.
“An alternative rule might require the trustee of an electing foreign trust to file Form 708 only in years where the foreign trust received a covered gift or bequest.”
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Text of the ABA sections letter is in TaxCore.
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